Saturday, 8 August 2009

Apologies, readers, for the long silence between posts! Shap has been threatening bodily violence, among other forms of retaliation, against me for some time (and rightfully too, though I would never admit it to him) for not updating when I should attempt to do so more diligently, especially during these exciting economic times.

Before the actual substance of this post begins, I feel compelled to share a couple of links that have been floating around the economic side of the blogosphere. These links and related discussions are, at this point, admittedly rather dated, but they make excellent reading for anyone interested in learning more about economics (and who isn't, really?). First, The Economist managed to provoke quite the discussion by featuring the state of economics as their cover story. Economics, of course, is a broad discipline, and the two fields whose reputation and credibly have been hit most hard by the global economic crisis are macroeconomics and financial economics. This blog has already covered the basics of the divergences within macro (whereas -- and I think I speak for both Shap and myself here -- we're less up to date on the nature of asset markets), though The Economist provides a fantastic overview of them as well. One of my favourite responses to The Economist's take on macro is this post by Berkeley professor Brad DeLong, whose blog I would highly recommend.

With that out of the way, I'd like to tackle another subject that has been floating around lately: what is the exact nature and size of the role that the U.S. Federal Reserve should play in monetary policy, financial regulation, and oversight of the American economy in general? Suffice to say, the Fed has attracted quite its share of public attention since it found itself at the centre of the effort to stabilise the financial system. It has already deployed monetary policy to its fullest logical extent by slashing short-term interest rates to practically zero, although there is research currently being done to see if it's possible to transcend the so-called zero-bound problem, and President Obama has proposed investing in the Fed greater powers of oversight regarding institutions deemed too big to fail.

Given existing public queasiness about the government's stabilisation efforts, the Fed has become an irresistible target. At the risk of grossly oversimplifying (often the case when speaking of politics), this can hold true for both those on the left, who fear that the Fed will favour Wall Street over Main Street, and the right, who believe that the Fed will produce greater economic distortions through the manipulation of monetary policy than if it simply let business cycles run their course. Representative Ron Paul, who more famously ran for president in 2008, has introduced H.R. 1207, a bill that would give Congress the right to inspect the various comings & goings of the Fed. It is slightly tempting to discuss Paul as a politician on the the partisan fringe -- after all, this is the man who has also sponsored a separate bill to outright abolish the Fed -- but the fact that 282 of his colleagues have signed on as co-sponsors of H.R. 1207 indicates that, on Capitol Hill, his sentiments are shared. Various high-profile media outlets (see: Forbes and Bloomberg) have also nursed this idea of an abolished or reined in Federal Reserve. Fed Chairman Ben Bernanke has clearly been feeling the heat, especially with the end of his term and the possibility of reappointment coming up in January, and held a town hall late last month (though we can only hope that he wasn't heckled à la poor Congressmen on August recess).

Threats to the independence of the Fed are not new -- after all, debates about the concept of a national bank date back to the founding of this country -- but the current complexity of the world of finance has given the Fed an unprecedented level of importance. It is here that defenders of common economic sense must make their stand: the ability of the Federal Reserve to determine monetary policy and to conduct all of the asset transactions required to do so must not be curtailed. Central bank independence is a key tenet of all modern and rational economic systems for good reason. Imagine, for instance, that Congress did indeed have the ability to influence interest rates. If we posit that the primary goal of elected politicians is to be re-elected and that presiding over good economic times is correlated with re-election -- both are fairly reasonable assumptions to make, I should think -- then it is only a step away to assume that Congressmen would set monetary policy to accomplish these ends. Perhaps it would involve lowering interest rates in order to boost growth, or perhaps it would involve raising interest rates if the public frets about inflation. In both cases, though, policy would be set with little regard for actual macroeconomic circumstances and fluctuate in accordance with poll numbers.

All of this would result in an extraordinary level of instability, but the scenario needn't that extreme for a similar outcome to emerge. If Congress has just enough leverage over the Fed so as to make the latter beholden to the former in some manner -- the audits proposed by Ron Paul's bill would be enough to accomplish this -- it could easily give the Fed grief for politically unpopular policies and limit its willingness to pursue them. Central bank independence would be compromised, and the introduction of the fickle mob into the equation would increase uncertainty about the direction of U.S. monetary policy. Uncertainty heightens risk, and, assuming that the majority of actors in the market are risk-averse, the presence of unmitigated risk means that the economy will be performing at a suboptimal level.

An interesting revisionist school of thought argues that the Fed actually isn't an independent institution, and, to an extent, there is some truth in this. The Forbes article that I linked to earlier in this post details the politics that surround such a powerful institution, and to deny that the Fed is apart from domestic and international political considerations altogether is ultimately naive. With that said, however, central bank independence is less about independence from political currents -- for better or worse, politics is the process by which, well, anything is accomplished in government institutions -- than independence of action. The Fed needs space to undertake policies that may not sit well with elected officials but are nonetheless economically necessary. If our legislators wish to affect the course of the economy, then they are welcome to play around with spending and taxation in their own sandbox of fiscal policy, but it would be folly to condemn the whole of our economic fate to such hands.

Sunday, 31 May 2009

The field of economics has come under a lot of fire as of late, an understandable situation considering the great contributions macroeconomists have made to the global financial crisis. However, even in prosperous times economics faces a deal of undue discrimination (personally, I would like to see President Obama make a true progressive choice for the Supreme Court by nominating an economist); the fact that there is a surprisingly lengthy article on the "dismal science" on wikipedia only further affirms the point. Naturally as a potential economist, I am rather biased on the topic, but I must come to the defense of my beloved field. I have a number of well-practiced arguments, which I will undoubtedly mention in the future. However, first I wanted to submit a defense by a semi-layperson.

This summer I am working at a relatively small consultation firm that implements programs for sustainable economic growth in developing countries. While some contracts are granted directly by developing countries, most are awarded by organizations like USAID. The president and co-founder of this business certainly has a great deal of experience in implementing these programs and boasts two masters in business-related studies from Harvard, but he and most of the other employees are not economists. For their projects, they find outside experts to bring in as ad-hoc consults for particular tasks. During my interview with the president, he *attempted* to explain to me exactly how operations at the organization work. While that was initially lost to me, the explanation for his motivation behind founding this business was not. He said that his personal goal is to make sure that no one suffers from a lack of choice (there was a story about him living in a shantytown that preceded that claim, but it's irrelevant to my point here).

While there are people who would prefer to return to those simpler times of subsistence, I am going to respond to the majority that do appreciate the option of choosing between brussel sprouts and broccoli (we'll ignore the stand-up economist's interpretation of Mankiw's principles of economics that claim choices are bad). In the field of economics, the crusade to bring choice to people the world over is embodied in development economics. Min has already touched on some of the macro-level disagreements in this specific branch, but on the micro level, the merits of development economics are clear.

The organization I work with specifically specializes in competitiveness issues. Although the nice models of "perfect competition" are clearly far from the realities of the economic environment, the idea that a business, or country, needs to be "competitive" is still true. Organizations are dedicated to the study of specific country's competitiveness, measured by several indices from education to the possibility of a coup; the principal study is released by the World Economic Forum (WEF) every year. In an increasingly globalized world, the importance competitiveness is amplified (see China or India). However, unlike some perspectives on the issue of globalization, the trend is not necessarily a "race to the bottom" anymore (see Making Globalization Work by Joseph Stiglitz) rather it is about productivity and specialization.

My employers do work all over the developing world, but their longest-term projects are in Pakistan, and every year since Pakistan has been included in the WEF report, they have co-authored the country-specific competitiveness report for the country. While Pakistani leadership may be interested in improving index numbers (we will call that the macro side), the many, many companies on the ground developing and implementing programs are interested in small, incremental improvements in the conditions of the Pakistani countryside. What has their work produced? Nearly 15% of the population has escaped poverty over the last six years (withstanding the effects of the Global Financial Crisis). Of course, these and other improvements can be attributed to favorable treatment of foreign business during the Musharraf regime, but also to work on the ground that opened up once unheard of possibilities for impoverished Pakistanis--through loans by Islamic banks, through improved infrastructure, or through the simple construction of cooling locations along routes so farmers could sell more milk to farther locations. Create the opportunities. Fulfill the opportunities. Create more opportunities. It is a very simple formula that has pulled millions out of poverty (in Pakistan alone).

The practicality of microeconomics extends far beyond the Pakistani countryside or "making money" in general. That, however, is a topic for another chapter.

Thursday, 21 May 2009

It is no understatement to say that the ongoing global financial crisis has reshaped many views about everything from derivatives regulation to geopolitics. One area that has been particularly shaken is economics, and, as countries continue to grapple with the tricky matter of stimulating economic recovery, macroeconomics has received the bulk of the attention. Economics, broadly and colloquially defined, is the science/art of balancing unlimited wants with limited resources. Macroeconomics, then, examines this problem at the national or aggregate level and, in its most basic formulation, looks at how those resources should be allocated in order to promote growth.

There's just one problem: macroeconomics does not have an answer to this problem -- or, more accurately, it has multiple answers and cannot seem to decide among them, and, as macroeconomists around the world wring their hands over this recession, the rifts between various schools of thought has never seen more pronounced.

So it seems to me, having just wrapped up a course in intermediate macro. My previous studies in macro, first at the Advanced Placement level and then in my international finance course, centred around a more classical, Keynesian approach that took the basic supply and demand model and extrapolated it to the national level. Aggregate demand and aggregate supply curves were our instruments of choice in AP. Aggregate demand was composed of consumption, investment, government spending, and net exports, and, whenever one increased or decrease through monetary or fiscal expansion or contraction, respectively, aggregate demand would respond accordingly, and so forth. This was complemented by the Philips curve, which embodies the inverse relationship between unemployment and inflation and could also be used to trace the effect of monetary and fiscal policy. In my college-level international finance course, I was introduced to the IS-LM model, where the IS curve represents fiscal policy and the LM curve allows for changes in money supply, as influenced by monetary policy.

As I proceeded through my intermediate macro course, though, not a single mention of IS-LM or aggregate demand/supply was made, except, perhaps, when my professor paused to speak of Keynesian economics with a distinct note of contempt in his voice. Indeed, the way he taught macro, one could have easily been under the impression that Keynesian ideas about the economy did not exist at all. Instead, he spoke of consumers and the government having fixed consumption preferences and rational expectations. Under this banner, I was taught, for instance, that taxing a person's income in old age will have absolutely no effect on how that income will be spent over a lifetime because the person in question will always want to spend x percent of his income when young and 1 - x percent of his income when old. When my class arrived at the very timely subject of business cycles, we spent a significant amount of time discussing an article that argued that, even if government were able to smooth out perfectly business cycles, this would only bring a negligible average benefit per capita. Indeed, I remember quite clearly the author concluding the article with a warning: governments should be less concerned about deviations from expected growth trends and more so with promoting policies that could be even more distortionary. This was accompanied by a discussion of the "Great Moderation," which stipulates that business cycles have become less severe in recent decades.

As Paul Krugman notes, this divide within macro is nothing new. Proponents of the rationalist school regard the Keynesian school as, well, irrational and simplistic, and, as for what the Keynesians themselves think, I would not know, having never received instruction in macroeconmoic theory from one. One thing, however, is clear: the rationalist school, with its belief in the declining importance of business cycles -- and, by implication, the declining importance of government intervention in economic activity -- had been ascendant in recent years, giving intellectual underpinnings to that ever expanding bubble of prosperity, the popping of which has led to the first worldwide recession since World War II.

On occasion, my mother, interested in what exactly what her tuition money was buying, would ask me what my macro course had to say about the current recession and government responses to it. I found that I could give her no meaningful response: theories about rational behaviour and expectations of future income had nothing to say about financial regulation or government stimulus (except, perhaps, that the government should not act, a notion I considered as outdated as, say, medieval witch hunts). Meanwhile, in the real world, Congress was wrangling with the president over the exact size and scope of the American Recovery and Reinvestment Act, the president was urging other heads of state to pass their own stimulus packages, and the Treasury Department was prepared to spend billions of dollars of government money to purchase legacy assets, thereby increasing liquidity and spurring private investment. Despite the very contentious nature of these debates, however, there appeared to a strong consensus that a massive infusion of public money into the economy was exactly what was needed. (Perhaps instead of asserting that "we are all socialists now,"Newsweek should have argued that we are all Keynesians now.) This stood in direct contraction to the material I spent a semester learning.

Here at the Economic Adventures of Min and Shap, we make no secret of our scepticism toward the field of macroeconomics. Speaking solely for myself, this scepticism in large part stems from the fact that the most modern work being done in macroeconomics has very little to say about the questions that macroeconomists are supposed to answer. To me, this indicates a discipline that has gone astray, and, for all of our sakes, may present economic turmoil force it to rediscover its purpose.

Tuesday, 12 May 2009

My fellow blogger Shap did a wonderful job of introducing us both the other day, so I need not preface my post with any further remarks on that front beyond saying that I am very excited to be blogging here and that I will be the one posting with British spellings. Because, you know, I can.

This particular post is, admittedly, rather influenced by a particular final exam I had to take last semester for my Introduction to the Politics and Economics of Development course, in which I was asked to analyse and evaluate the effectiveness of foreign aid. The concept of foreign aid -- here defined as a bilateral or multilateral transfer of income to a country for the purpose of development -- is simple enough: country X gives low-income country Y a certain amount of money, which is supposed to manifest itself in higher economic growth per capita, lower mortality rates, or whatever development indicator of your choice. It's a straightforward enough notion, but a contentious argument is unceasingly waged over just how effective this approach is.

The root of this debate lies in the very stuff of foreign aid: numbers. If someone could just demonstrate an ironclad relationship between the amount of aid given to a country and its resultant economic performance (for the remainder of this post, let's posit that the economic indicator of importance is GDP growth), then all disagreement could be theoretically resolved. Alas, if it were only that easy. In trying to pin down a relationship like this, the litany of other factors that can affect GDP growth (political stability, geography, demography -- really, the list is practically endless!) must be, in essence, taken out of the calculation and held constant, therefore isolating the growth from external, non-aid influences. Alas, if it were only as easy as that! As many thinkers in the field of development have noted, foreign aid is itself affected by other variables. It is often observed, for instance, that the bulk of foreign aid is given to middle-income countries -- countries with something of a track record of minimally competent governance and economic growth -- rather than to the poorest countries. Therefore, any serious study of the relationship between aid and growth must take into account all of the variables that might aid as well.

Clearly, one doesn't have to be a professional econometrician to see that this seemingly simple exercise can get very tricky very quickly. From the simplest of models, the single-variable regression that seeks to answer, "When X changes, what happens to Y?" (a concept known as correlation), economists have derived ever more complicated models that can not merely control for any number of variables -- that is actually quite easy for an economist to do, provided that the economist has a working computer -- but also attempt to answer the only question that, in the end matters: when X changes, does this change in X cause a change in Y?

Given that all sides of this debate have amassed a plethora of evidence for themselves, the only conclusion that I can try to draw is that there just isn't a conclusion. And nobody should expect one either: the country, as an economic unit, is a creature so multifaceted that to grasp the whole of it with a single statistical model seems, well, foolish. At a certain point, perhaps foolish is what this entire endeavour is. After all, it isn't as if developing countries are machines that take aid and magically form it into improved economic growth; rather, the channels of aid-growth-development causation are less channels than they are an indiscernable thicket of strings with dead ends and knots in the middle. What more, the debate about the effectiveness of foreign aid overshadows the most pressing issue of all: the livelihood of billions of individuals trapped in poverty around the world.

Perhaps, then, the macro approach to aid is not a viable way of either dispensing aid or evaluating its usefulness. In its lieu, I would suggest a more micro approach that may be less ambitious in its goals but is ultimately more effective in facilitating development. Foreign aid should be specifically linked to a specific objective and then designed to achieve it. This method is less ambitious in its goals but may ultimately be more effective in facilitating growth and development: if the target of aid is more explicitly defined, then could it not be easier for donors to structure it in such a way that provides incentives for behaviour that leads to higher growth? In recognition of the fact that the many facets of development are intrinsically linked, aid can be organised into individual projects, each one oriented toward a particular goal. In this manner, perhaps positive spillover effects can be generated, thus improving lives the world over.

There is, of course, a great deal of unsubstantiated idealism left in this idea, but it cannot be any more inconclusive than the foreign aid status quo.

Sunday, 10 May 2009

With great pride Min and Shap present the child of their mutual interests, a compendium on all things economics (save the black hole of knowledge known as macroeconomics). Two international political economy majors at the Georgetown School of Foreign Service, we have fallen in love with what some would call a "dismal science." We see economics not only as an alternate lens to studying interaction from the consumer to the country but also the glue that ties all terrestrial actors together and the most practical way to improve life the world over.

And so, we decided to present our adventures and horrors as we continue to study economics and continue to find economics affecting lives in subtle, yet powerful, ways. As the world continues to associate economics exclusively with the collapse of the international financial order, we hope to highlight both the successes (microeconomics) and failures (macroeconomics) of our future field.

We thought it would be appropriate to begin with a light-hearted introduction to the basic principles of economics. The video, shown to us on the first day of intermediate microeconomics, emphasizes the wonderful simplicity of economics and a few other general truths (note principles 8-10).

Through our efforts, we hope to provide an avenue for constructive discussion and debate about economics, political economy, international affairs, and whatever else piques our interest. Macroeconomists need not participate. (We jest, mostly.)